Personal Finance: How to save automatically

26Jul

In case you’re a new reader, my blog is geared toward younger people and things they should be doing. Like how to save effortlessly and how to be successful in college and learn new things. I’m going to write a lot about how to achieve certain goals that almost everyone has for the future, and that nobody ever accomplishes. Occasionally I’ll write opinionated stuff or I’ll write about business in general, like why Digital Retail should be embraced much more than it is by corporations.

Most people want to save. For the future, for a car, for a home, whatever. Everyone generalizes saving, thinking that they should save and it’s a good idea to save but just about noone does. Chances are if you have a savings account that it’s linked to your checking account and by spending thirty seconds on your phone you can instantly swap funds over and act like that money was never even saved.

Here’s some real math.

The average wedding costs $28,000. If you’re going to afford this and are 25 years old you’d need to accumulate $1,000 each month just for your wedding in order to be able to afford it. If you’re not 25 years old, do your own math to calculate how much you need to save. Hint: If you’re 20+ it’s a ton of money each month.

Ask yourself, how much do you think you spend on Christmas gifts? You probably think somewhere in the area of $200-$300 unless you’re still in college. Most people spend a lot more than that. Let’s say $500 is average, that’s about $42 a month. Even at $200 it’s still $16 a month. But you’re not paying monthly, instead you’ll be hitting your head with a hammer wondering how you’re going to buy your parents or your new niece a Christmas gift. It’s a lot of money. Now imagine having it in a savings account so you don’t need to worry about it.

In fact, ask yourself how much you spend on car repair, home/furniture repair, things you might consider a “rare” occurrence. It’s really not though. You can calculate an average on how much you spend to repair your car each month and it probably ballparks around $400 a year for the average person including renewing your registration. Now how much do you spend on home or furniture? Probably a lot more than you think. Glassware breaks, chairs break, your computer can break and if you have a home then this expense skyrockets. Let’s say you rent and you average $500 a year in expenses because stuff happens. At $900 a year that’s $75 a month.

Then there’s unexpected expenses. Breaking an arm, or have something completely random and terrible happen like losing your car and it’s not covered by your insurance. There are all kinds of things that can go wrong that we just wont see coming, and the average person spends 10-15% of their income after taxes. Let’s say you make $15k a year after taxes then you’d have to save $125 a month to accumulate for an average accident at a 10% rate.

I’m not trying to scare you with big bold text and “fancy” math, but real saving is something everyone needs to do. With this math you’d have to save about a grand each month just for expected expenses that you’re going to have. I didn’t even calculate for a whole lot of stuff, like a house down payment, a car down payment, saving for retirement and more.

Hopefully you’re reading at this point because you know you want to save, and you’re willing to take action. So I’ll give some great advice for saving.

Saving for Retirement: You need to employ the use of a 401(k) if your employer has one and if they have a match, you need to deposit at least the amount required in order to get that match (It’s free money.). Then you need to get a Roth IRA account (Assuming you meet the restrictions; simple rule of thumb, if you don’t make six figures you probably qualify) and deposit as much as you can into it. Both give you great funds for retirement and you most likely won’t need to work when you’re 70-80 years old. For information on why these two accounts are so important and some great methods to maximize how much money you can get from these accounts while minimizing your effort, visit Ramit Sethi at Iwillteachyoutoberich.com and read his book. He dives into that with extreme detail.

Saving in General

When I say saving in general I mean for things you could possibly need the money for at any moment, like if you where to lose your job/car/home/a limb or whatever. Some things you should save for include a down payment on a home, vehicle expenses, medical expenses, home/furniture expenses, unexpected expenses and more.

What you’re (most likely) doing right now: You’re either not saving or you’ve got a savings account linked to your checking which allows you frequent/free/fast transfers to your checking at any time sometimes through the use of even just a smartphone or a phone-call. Your savings account probably just has one big lump sum in it. Here’s a hint: That’s not a savings account. It’s a glorified extension of your checking account that only exists because you think you should be saving but you’re really not, and you most likely withdraw and transfer from it all the time. If you don’t, you still have no idea what the money is actually for and probably tell yourself it’s there for “just in case”. Regardless, you don’t commit to it as much as you should. This is really blunt, but I found it to be an issue with everyone I’ve ever talked to about it under the age of about 40 or so.

Here’s my savings account after I had just opened it:

I have an individual “account” for all of my perceived expenses. Medical expenses, vehicle expenses (including future estimated down payments) and house expenses (Including furniture expenses and future estimated down payment, even though a house down-payment warrants a whole new account). I have a bill cushion that I intend to save toward until I reach a full 6 month bill-cushion, in case something terrible happens. I have one for investments so I can open up more investing funds. I have one for vacations, because everyone goes on vacation and I’d like to too. Hobbies and fun include camping, cookouts, target shooting and more. Games and media include books/movies/television/videogames that should be in a normal person’s “hobby” category, but I spend so much on these each year it warrants saving for. I want to go back to college and I’m probably going to have a wedding, so I’m saving for those too. Then there’s taxes, which I only input a flat amount for things I know I’ll owe on tax day (Like when I get a 1099 for freelance work, I’ll put in 30% of that straight to my taxes account just in case I owe money at tax time. If I don’t? I defer all that money to my other categories”.

This is called an “Envelope” or a “Folder” system. Each account acts like a folder, when it’s really a whole new account. Why should you do this? It helps in the way that it sets goals and helps you maintain those goals almost subconsciously. This November/December has about 5 videogames coming out that I really want to buy, but I have a Games and Media envelope and the second it runs out, I’m not going to buy any more games. That’s it. The system discourages you from dipping into savings categories so you only spend what you put aside for that particular item.

But there’s more to it, psychologically, than just that. When you create your own categories, you need categories for fixed and predicable costs like medical/taxes/home/furniture/vehicle etc. Then you need categories for predicted expenses like your wedding (and you should have an IRA + a 401(k) for retirement) and things like college whether it be for you or your children regardless if you have them yet or not. Now that you have these categories, you need to find categories that you regularly spend money on. Stuff you find yourself dipping into your savings account for. A lot of people might consider eating/drinking at restaurants. For me, it was media, especially videogames. So I added a whole category for it that I regularly contribute to so I could save for and spend money on the things like this. You should do the same. Last but not least, I do have a “blank” category that exists just in case I completely missed something. That’s the blank account and I capped it at $100 just in case. I already mentioned how to calculate how much you need to save for your unexpected expenses folder so make sure you get that one too.

The mentality of saving exists for all of us, while actually doing it is difficult. Almost all savings accounts allow you to categorize like I did, and adding the “envelope” system to your savings account can really help you keep your goals in check and just generally save for the things you need you know to save for. But there’s another aspect of saving, two actually, and here’s another method to further deter you from regularly withdrawing from your savings account. You need to have a savings account at a different bank. My checking account is with Bank of America, and I negotiated with them to waive all of my fees and minimums. Then I opened up all of my savings accounts at ING Direct. I don’t really care what bank you open yours with but I will recommend one in a bit, as long as your accounts aren’t with the same bank. When they are you can easily transfer funds and it’s almost always instant. With a different bank it takes three days to transfer funds. This is a good thing, 100% of the time. Almost all of the time you’re going to want to dip into your savings account, it’s going to be on impulse. By making it take three days, you have time to think about it. By the second day you probably realize you didn’t even want it. This prevents impulse buys from destroying your savings account like they do for most 20-somethings.

Now you know how to keep what you’ve saved for, and how to more responsibly save. But how do you actually save? You probably pop in a few bucks here and there when you feel like it. I need you to calculate your expenses. Outline all of the categories you want to save for and guesstimate how much you need for each. Do a quick Google to figure out the average house down-payment and the average age someone buys a house, then take that age and subtract yours and divide those years into months, further dividing into the down-payment so you know how much per month you’d need. When calculating expenses take into consideration your bills, potential charges, regular things like license/registration renewals, add a future car down-payment to your vehicle expenses category and more. Make sure each category has its own monthly figure, and that should be your goal. Now subtract from your monthly income, after taxes, your bills and your now founded savings. Then take 15% of that and put it in the “Unexpected Expenses” category each month. Congratulations you’re a little smarter when it comes to your own financing now. You now know how much money you should be putting in each folder/envelope/category, whatever you want to call it.

Now you need to actually deposit the money. If you can’t reach your goals because you don’t make enough money, don’t worry about it. Deposit as much as you can toward it without bankrupting your other categories. It’s alright to only get part-way there, because part-way is infinitely better than doing nothing. As long as you have some money responsibly saved you’re doing better than 90% of the population. The actual method of depositing your money into your savings account needs to be automatic so you don’t deposit less than you should. Schedule monthly automatic withdrawals from your checking account, into your savings account.

Here’s how I do it, for your own image. My money get’s deposited directly into my checking account via “Direct Deposit”, if you don’t use DD you should, there aren’t any cons and tons of pros against a physical check. Two days after my funds are scheduled to be deposited, my savings account automatically withdraws the funds I set for each category. By doing this I don’t ever need to think about saving, and I give myself two days in case I don’t get the money I expected and need to go into my savings account and edit/cancel the withdraw (Like a paycheck doesn’t come or it’s less or more than it should have been). Automatic savings. Every month I peak into my savings and my jaw drops at how much money has accumulated that I had no idea was really there. Edit my system for your own. Do you use paper checks? You might want to have the automatic withdrawal scheduled for a week after your paycheck is scheduled to arrive, in case the banks are closed for whatever reason and to give yourself a few days to deposit and clear the cash. Are you hourly and your pay fluctuates? Calculate your average earnings over the period of at least 3 months and withdraw based on that figure, and give yourself three days notice for the withdrawal in case your paycheck is weak on week. Get paid bi-weekly? Split your withdraw after each scheduled check. Just make the system your own so it requires little effort and so each paycheck saves a little bit.

The best part about all of this is the psychology behind it. This system forces you to save monthly and deters you from withdrawing, and organizes your savings so that you can stick to your goals and better track and use the money you’re saving. It’s fool-proof and everyone should do it. If you have questions about this system email me at kjdprofessional@gmail.com

Recommended Savings Account

I highly recommend ING Direct “Orange Savings” accounts.ingdirect.com

I have no affiliation here, I just like the account. You can open an Orange Savings account very easily, you just need a pre-existing checking account to link to. The account is free, has no minimum, and you can open as many as you want at any time. I have something like 13 accounts (see above) and opened most of them with as little as $10. They have a high interest rate, and the user interface is very simple. The bank overall is great and my experience with their customer service has been phenomenal.

All you have to do to use the Envelope system with this bank is click “Open” and open up a new Orange Savings account, simply titling it for your category. Each account takes three days to receive a fund and three days to send money back but add a layer of deterrence of use by holding funds for a week after they receive it (A system I really like). Each account has its own “Schedule a Withdraw” feature that allows you to put a specific amount each account is going to withdraw from your checking account. By linking it to your checking account you only ever have to input information for that account when you open up your very first account. This bank has a ton of great features and has literally no cost.

They also have a no minimum, no fee Roth IRA account which is really good, but I’m finding their investing section (Sharebuilder) to be a little overly complex with the UI and I haven’t heard great things about their options for funds. They’re by far the best for saving, though. Check them out, I dropped Bank of America within a heartbeat for these guys and have been happy ever since.

Security Savings

When I say security savings, I mean a savings that’s out of sight and mind. Savings that you have access to, but exists for when something just goes wrong and you need money. Like when my internet and phone went out and I needed to swap some cash. Or when my car was low on gas but I couldn’t wait three days to transfer funds and my checking account was just about empty. This is cash that’s securely hidden but readily available in case you need it.

Most people that talk about personal finance don’t suggest this because cash that’s just sitting around doesn’t gain value like it did if it was in an interest-yielding savings account or an investment account. Technically it loses value over time if you count inflation. I agree with this completely and I don’t think you should save much money as cash, and it should instead be maximized to increase your earnings.

What I suggest is saving about $200-$300 in cash for when technology fails you, which occasionally happens. Get to that amount and cap it and maybe write a reminder somewhere so you don’t forget about it. In one of my sock drawers I’ve got $100 stashed in a small metal tin, just in case I don’t have time to transfer funds but actually need money. My most important one is in my car, in a small locked container under one of my seats, in case I run out of gas or my cards fail for whatever reason and I need some money real quick. I only have $200 stashed away and I recommend to keep at least those two places, and maybe you should stash $100 in a place that you might need to access it really quick

The key to “security savings” is to keep the money available to you but unavailable to everyone else even though it’s physical cash. Small, lockable containers made of metal are my favorite. I hide them in areas most people wouldn’t ever think about looking or even accidentally come across, so when I take my car to the shop I’m not worried the guy’s gonna find it. I haven’t had any issues and I usually hide mine so well that no one will find it. I highly recommend not just hiding it well, but making it extremely difficult to get to if someone does find it. For instance, you can take a steel cable with a lock on it (like a firearm trigger lock or a laptop cable lock) and tightly tie it around your container and an object that’s difficult to move, like the steel frame of your seat. It makes it almost impossible to get to, and it’s a place that’s difficult to find. I check on these once every week or so, don’t be afraid to spend a little money to make it secure. It’s there for when technology fails, and has paid out a few times.

Conclusion and Actions

1. Open up a new savings account not linked to your checking account, preferably one at ING Direct.
2. Write down all potential categories you might need to save for
3. Calculate (as accurately as possible) how much you’d realistically need to save for each category, each month
4. Calculate, against your actual income, how much you actually can save for each category each month
5. Set up “envelope” accounts for each of your planned categories
6. Set up automatic withdrawals from each accountThis process will take you ~1-2 weeks; calculations take just an hour or two

Bonus: Get two palm sized, metal, lockable containers and find to places (preferably one in your house and car) and secure them and hide them in a great spot with $20-$100 in each.

That’s it. Sources include Ramit Sethi at iwillteachyoutoberich.com who goes over a system like this and much more.